When we were at BbWorld the week before last, Blackboard's executive management pushed back vehemently on our analysis of how their high levels of debt could impact their business decisions. We heard their strong disagreement expressed in our very first meeting of the conference from Chief Learning and Innovation Officer Phill Miller and in our very last meeting from CEO Bill Ballhaus.
We stand by our analysis. In fact, Blackboard's pushback had the opposite of its intended effect. We left BbWorld more convinced that we are right rather than less.
But in fairness, there is an empirical fact of the matter here, and we do not yet have conclusive public evidence that the company's high levels of debt will, in fact, affect their business strategy. So here's what we're going to do:
- I will summarize their position as objectively as I can.
- I will explain why we don't find their position persuasive.
- I will lay out the signs that concrete evidence we will be looking for going forward that will either support or undermine our thesis.
- Phil and I will publish updates as we monitor these signs and, if there is no additional public evidence of our thesis by BbWorld 2019 (or strong evidence emerges that we are wrong before then), then we will publish a mea culpa post.
The public kerfuffle of the last couple of weeks has been over our reporting that Canvas has (barely) surpassed Blackboard in US market share. But the focus of the company's pushback at BbWorld was on the financial claims. The heart of the argument we heard was essentially the same as the one articulated by Blackboard to the Washington Business Journal:
A company spokesperson said in a statement that Blackboard was a "healthy business with a proven and sustainable business model" with strong financial backing from its private equity investors, who have placed hundreds of millions of dollars more over the last two years.
"We have made a strategic decision to focus on the future instead of just quarterly results or debt ratings. Thus, we’ve chosen to focus investments on long-term, market-driving opportunities that meet the evolving needs of our clients, including but well beyond the learning management system (LMS),” the spokesperson said in an email.
We're not aware of public information about the "hundreds of millions of dollars more" that Blackboard claims their owner, Providence Equity, have placed in the company over the last two years, but Providence's willingness to continue pouring money into Blackboard going forward is really the key question. Ballhaus argued to us that the amount of debt that Blackboard is carrying is a strategic choice that he and the private equity investors—he used the pronoun "we"—make together. In particular, he argued, "we" could choose at any time to invest more money in the company, paying down debt in exchange for equity. Further, he argued, it's logical to assume that Providence would do so if needed because "they only make their money if we improve."
Why it's not credible
Paying down debt in exchange for equity, called "recapitalization," is a strong vote of confidence by a private equity (PE) owner. First, since debt holders get paid before equity holders in the event of bankruptcy, it increases risk for the PE firm. Second, it would mean a substantial investment of cash, which is partly what PE firms typically try to minimize by requiring the companies that they own to take on substantial debt in the first place. When PE-owned companies find that they are in danger of being unable to make their debt payments—which both Moody's and S&P Global Ratings have said is currently the case with Blackboard—the PE owners can and do employ a number of different strategies that are financially less risky to them in order to address the problem, either instead of or in addition to recapitalizing.
For example, when Cengage Learning found itself with unmanageable debt levels after its acquisition by private equity, they filed for bankruptcy:
“The decisive actions we are taking today will reduce our debt and improve our capital structure to support our long-term business strategy of transitioning from traditional print models to digital educational and research materials,” Michael Hansen, Cengage Learning’s chief executive, said in a statement.
To be crystal clear, I am not suggesting that Blackboard is likely to file for bankruptcy. Providence Equity has other options at its disposal, some of which I will write about in the next section.
Rather, the point is that Ballhaus' claim that we should just assume Providence will see it as being in their interest to recapitalize Blackboard is not credible on its face to anybody with even passing knowledge of how private equity companies work. For example, the tone of the Washington Business Journal article I referenced above, which (obviously) was written by a business reporter, suggests significant skepticism that Providence will not let the company's debt challenges impact their business decisions. The industry experts we typically consult with when writing financial or business stories like this one were even harsher in their evaluations of Blackboard's position. Two literally laughed out loud at it.
Further evidence we will be looking for
All that said, there's a lot we still don't know. Because Blackboard isn't publicly traded, we don't have very good access to their financial information (though Moody's and S&P do). And we certainly are not privy to the conversations that Ballhaus has with the company's board of directors. It's worth noting here that, in addition to being CEO, Providence chose to make him Chairman of the Board. So we will still label our analysis here as a (confident) hypothesis, subject to revision based on further empirical evidence.
Here are a few actions Blackboard could take in the future that would indicate Providence Equity has chosen to push Blackboard to solve its own debt problem rather than making it go away with more of Providence's money:
- Sell off one or more parts of the business: A Bloomberg piece written by journalists from their distressed debt desk reports, "With some of Blackboard’s bonds selling at deeply distressed levels, Ballhaus is crafting a comeback, and possible options include the sale of its payment processing division, said the people, who asked not to be identified because the discussions are private." Said payment processing division, Blackboard Transact, is a cash cow for the company. If Blackboard sells off one of its more profitable business units at a time when the company is having trouble making debt payments, that would indicate a choice by Providence Equity to find a way to reduce debt pressure that is less risky for them in terms of cash investment but more risky for Blackboard in terms of long-term health. Particularly since Providence already tried to sell Blackboard once and has now owned the company for well past the normal sell-by date that PE companies like to follow, the sale of Transact might suggest further moves to follow.
- Unload expenses (like office space): The Washington Business Journal article notes, "Blackboard is also interested in unloading its 70,000 square feet of office space at 1111 19th street, with 12,000 square feet already sublet, according to an April post on Tech Office Spaces. It's unclear where Blackboard will go if it succeeds in leasing out its entire footprint. Blackboard stood to benefit from a tax rebate program for companies that agree to sign 50,000 square feet for at least a dozen years, valued at half the company's tenant improvement costs, or a maximum of $5 million over five years." Of course, companies take cost-cutting measures all the time, regardless of their financial health. The business reporter's phrasing suggests that he may be detecting a whiff of desperation in the specifics of this transaction. Since that's his expertise more than ours, we'll be looking for additional confirmation of our thesis, such as if Blackboard were to...
- Significantly restructure with major layoffs: If Blackboard were to move to a smaller office while also laying off employees—beyond those that might leave in a sale of a business division or the slow leak of headcount that the company has been having for a while now—that would certainly be an indicator that Providence is not ready to just give Blackboard the money the company needs to complete a turn-around and is instead pushing them to solve their own financial problems.
Given the sourcing of the first two potential indicators, we will not be surprised if at least those two come to pass by the end of 2018. Time will tell.
What evidence would suggest that our analysis is mistaken? The strongest would be if Providence recapitalizes Blackboard. Even that would not be black and white; for example, Cengage's owners recapitalized the company along side of having them declare bankruptcy. The details will matter. But a significant recapitalization—where "significant" is defined by the markets and the financial experts—certainly would indicate that Mr. Ballhaus' characterization of Providence's willingness to invest further in Blackboard's success is more accurate than current evidence suggests.
The other thing that could happen is nothing. If a year passes and Blackboard manages to weather the debt pressure without having to make any major moves, then it will only be fair to expect e-Literate to publicly revisit our analysis.
And of course, we are still listening to any arguments that Blackboard executives are willing to make. While they haven't persuaded us thus far, we have accepted their invitation to keep the dialog going, and we remain open to more persuasive arguments. We will hold ourselves accountable, just as we will hold Blackboard accountable.
But honestly, I don't think we will need to wait a year for public evidence that Providence is not going to wave its magic wand. I predict we will be writing a follow-up story within six months.